The Securities Fraud Charge

Only slightly less deafening than the corporate-scandal headlines of recent years has been the hollering of regulatory agencies taking credit for having uncovered them. Given this, the discretion with which the U.S. attorney, FBI, and SEC handled the Martha Stewart investigation during the winter and spring of 2002 is to be applauded. Yes, devoting resources from not one or two but three government agencies to a single sale of 4,000 shares of stock on a day in which 8 million were sold smacks of overkill (not to mention selective targeting), but for six months, as the investigators examined evidence and interviewed witnesses, the proceedings simmered quietly in private, protecting the reputations of not only those under investigation, but those who depended on them (the shareholders and employees of Martha Stewart Living Omnimedia, for example). Privacy helps investigators, too—less pressure to indict first and evaluate later—but for those whose lives and careers hang in the balance, it is a godsend. The relative burdens of proof in the court of law and the court of public opinion are miles apart, and as Stewart’s experience shows, it is not only convictions that wreak havoc, but insinuations and accusations.

Still, nothing stays private forever, especially when so much can be gained by making it public. In June 2002, a fourth government agency entered the Stewart investigation—and declared ownership with the subtlety of a Rottweiler charging into a dog run. On June 6, “congressional investigators” and “people close to a Congressional investigation” told the New York Times,Wall Street Journal, and other outlets that they were investigating the suspicious timing of Stewart’s ImClone sale. And then, predictably, all hell broke loose.

Martha Stewart Said To Sell Shares Before F.D.A. Ruling (New York Times headline)

Stewart Sold Stock After Calling CEO (incorrect Seattle Times headline)

Congress Puts Stewart In Pressure Cooker (N.Y. Post headline)

Heat Is On Martha Stewart (CBS Marketwatch headline)

That summer, with the country reeling from the crash, Wall Street and corporate scandals (see Full Disclosure), and a painful recession, business executives were guilty until proven innocent. Over the next few weeks, the headlines exploded like mortar shells.

Under this barrage (for these and other stories, see the 762-page Exhibit E of Stewart’s motions memorandum), Stewart’s personal image soon disintegrated, and the stock of her company, Martha Stewart Living Omnimedia, got cut in half. As chairman and CEO of the company, Stewart had a duty to address the central charge—that she had been tipped off about Erbitux. As a human being, moreover, she was probably so outraged and humiliated that she was desperate to do some speculating (read: character assassinating) of her own. In hindsight, given the ferocity of the media typhoon, one could argue that Stewart handled herself with restraint. She did say a few things, though, and what she said got her indicted for criminal securities fraud.

The gist of what Stewart said that June was that she hadn’t been tipped off about Erbitux; that she’d had an understanding with her broker to sell the stock if it broke $60; and that her trade had been “entirely lawful.” The government alleges that Stewart’s communications constituted “a series of false and misleading public statements” made “with the intent to defraud and deceive purchasers and sellers of MSLO common stock and to maintain the value of [Stewart’s]own MSLO stock”—in other words, an attempt to trick investors into thinking that all was hunky-dory. This is by far the most serious charge Stewart faces (potentially punishable by years in prison and millions in fines), so it seems worth a closer look.